Monday, March 18, 2013

The War on Common Sense Continues, by Time Duy: This weekend, European
policymakers opened up a new front in their ongoing war on common sense. The
details of the Cyprus bailout included a bail-in of bank depositors, small and
large alike. As should have been expected, chaos ensued as Cypriots rushed to
ATMs in a desperate attempt to withdraw their savings, the initial stages of
what is likely to become a run on the nation's banks. Shocking, I know. Who
could have predicted that the populous would react poorly to an assault on
depositors?

The situation remains fluid, with even the final hit to depositors still
unknown. The
Financial Times is reporting that authorities are considering altering the
plan to shift the burden on the tax away from smaller depositors. Moreover, at
this point it is not clear is the parliment will concede to the measures despite
a last minute push by ECB officials to affirm the deal before markets open
Monday. And the impact on other nations in the European periphery remains
unknown.

At this point, I would imagine the damage is done, regardless of any
modification of the plan. Cypriots know that their savings are now on the
bargaining table. To be sure, there will be repeated reassurances that this is
a one-off event, but how trustworthy are such assurances? Indeed, if Greece is
any example, this will not be the last bailout, and thus plenty of time for the
European policymakers to insist on another bite at the apple. Perhaps if
authorities completely backtrack on the plan could they stave off a bank run,
but even on that I am not confident. Trust is easy to lose and hard to earn.

The bigger question is what does this mean for the European financial system
as a whole? Will depositors across the Eurozone view Cyprus as a unique
situation? Or will Greek citizens come to believe that the next tranche of
bailout funds might come with a new conditions to shore up government finances?
Will taxes on deposits be an element of any future bailouts? If so, Italian
and Spanish depositors might come to view their mattresses as safer than the
bank.

Perhaps expectations of a broader bank run are premature. Early
reports from Spain claim that no such run is in the making (of course, what
else would they say?). But I suspect this is still a game-changing event, sure
to make the financial system more unstable by aggravating the negative feedback
loop that surrounds financial crises. What else could be the case when you
remove a basic safeguard against panic in the banking system?

I can only sample the amazing amount of excellent commentary in response to
this new development. Frances Coppola,
in a must read piece, explains the economic consequences:

The effect of large and small depositors removing funds on that scale will be
a brutal
economic downturn as the money supply collapses. In particular, the dominant
financial sector will suffer a severe contraction, putting thousands of jobs at
risk and paralysing lending to Cypriot households and businesses. And that is IN
ADDITION to the estimated 4.5% economic contraction that is already happening
due to austerity measures imposed on Cyprus in 2012 to reduce its fiscal
deficit, and the further measures required in this bailout.

Yes, exactly how will this help Cyprus emerge from their recesssion? If you
guessed "it won't," you are correct. But expect European policymakerst to drone
on about how their plan will restore confidence in the economy of Cyprus.
Coppola also bemoans the culpability in the ECB:

The FT confirms the ECB's role in forcing through the deal. It says the ECB
threatened to stop providing liquidity to Laiki, Cyprus's second-biggest bank,
which would have caused an immediate disorderly collapse. I have written
previously about the ECB's disgraceful
behaviour. This is the worst example yet.

Like me, Karl
Whelan is challenged to see that this was a good choice:

Even if we get through the next week without panic, my gut feeling is that
this decision is a bad one and the Europeans should have chosen from the other
two options on the table. Over the longer-term, I doubt if financial
stability in the euro area (and the continued existence of the euro) is
compatible with a policy framework that doesn’t protect the savings of ordinary
depositors.

Nick
Rowe points out that savers in Cyprus are suffering
disproportionately because they lack the ability to print their own currency:

The difference is that inflation from printing too much money is a tax on
currency too. Cyprus cannot tax currency; it can only tax bank deposits.

Joseph Cotterill (another must read piece), identifies the reason to spread
the pain to small depositors:

The spin that this is about spanking money-launderers is rubbish. The 9.9 per
cent levy will be the cost of doing business for the average CIS corporate
shell, as Pawelmorski notes. More to the point, someone clearly balked at
increasing the rate above 10 per cent for big-ticket depositors — because why
else distribute pain to small holders to make up for it. Someone has an eye on
Cyprus somehow maintaining a future as an offshore banking centre.

Too big a hit to large depositors would end any hope that Cyprus could hold
onto its biggest industry. The anonymously penned
Some of it Was True blog wonders if there are any rules in European finance:

Probably of more lasting importance is the latest bout of rule-changing by
the authorities. Debt unwindings are generally well-defined in law. First
equity, then sub debt, then deposits and senior bonds together, and all treated
equally. Most of these principles have been tweaked over the last few years, but
the tweaks are getting steadily more aggressive. The ECB, holders of Athens-law
and foreign law Greek debt all got different treatment; the Dutch didn’t
restructure SNS Reeal paper, they confiscated it; the Irish banned lawsuits
against the ultimate wind-down of Anglo Irish. This is scratching the surface
compared with the rule-changes of the past but
it’s getting steadily more creative.The referee has gone from being
quasi-neutral arbiter, to pulling off his black shirt to reveal a Manchester
United one underneath and awarding himself a series of penalties. While there’s
clearly no point in market participants playing the shocked blushing virgin in
the face of a situation where the consequences of following the legally-logical
steps are socially unacceptable, the uncertainty generated creates costs too.

It was inevitable that we would be in crisis again. The austerity world view
of crisis resolution is completely at odds with the capacity of the euro zone’s
institutional architecture to handle a crisis. And so, we keep doubling down on
the same policy of austerity in exchange for reforms which has created the
downward spiral to begin with. I wish I could be optimistic here. But I think it
is going to get worse. I hope I’m wrong. And I certainly hope that periphery
depositors still have enough faith in the euro to ride this one out. If the
Cyprus panic metastasizes, it will get ugly.

Unbeknown to the Cypriot delegation members as they entered the hulking Justus
Lipsius summit building in Brussels on Friday night, their fate was already
sealed: their German counterparts wanted about €7bn for the estimated €17bn
bailout of their country to come from deposits
in the country’s banks.

“They were hand in hand with Finns, who were much more dogmatic,” said one
senior eurozone official involved in the 10-hour marathon talks that stretched
until 3am on Saturday morning. “Had that not happened, full bail-in,” the
official added, using the terminology for wiping out nearly all Cypriot bank
accounts.

Felix Salmon see the German influence as bad for Euope and Germany itself:

The Cypriot parliament is probably not going to revolt this weekend, but any
politician who votes for this bill is going to have a very, very hard time
getting re-elected. This decision is important not only because of the precedent
it sets with regard to bank depositors, but also because of the way in which it
points up just how powerless all the Mediterranean countries (plus Ireland) have
become. More than ever before, it’s Germany’s Europe. That’s bad for Cyprus —
and it’s not even particularly good for Germany.

"It was the position of the German government and the International Monetary
Fund that we must get a considerable part of the funds that are necessary for
restructuring the banks from the banks owners and creditors - that means the
investors," German Finance Minister Wolfgang Schaeuble told public broadcaster
ARD in an interview.

"But we would obviously have respected the deposit guarantee for accounts up
to 100,000," he said. "But those who did not want a bail-in were the Cypriot
government, also the European Commission and the ECB, they decided on this
solution and they now must explain this to the Cypriot people."

Bottom Line: In the short-run, the implications for the European periphery
might be limited. But, in the long-run, it is hard to see the assault on
Cypriot depositors as anything but a step backwards for financial stability in
Europe. This crisis remains far from over.

Comments

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Fed Watch: The War on Common Sense Continues

Tim Duy:

The War on Common Sense Continues, by Time Duy: This weekend, European
policymakers opened up a new front in their ongoing war on common sense. The
details of the Cyprus bailout included a bail-in of bank depositors, small and
large alike. As should have been expected, chaos ensued as Cypriots rushed to
ATMs in a desperate attempt to withdraw their savings, the initial stages of
what is likely to become a run on the nation's banks. Shocking, I know. Who
could have predicted that the populous would react poorly to an assault on
depositors?

The situation remains fluid, with even the final hit to depositors still
unknown. The
Financial Times is reporting that authorities are considering altering the
plan to shift the burden on the tax away from smaller depositors. Moreover, at
this point it is not clear is the parliment will concede to the measures despite
a last minute push by ECB officials to affirm the deal before markets open
Monday. And the impact on other nations in the European periphery remains
unknown.

At this point, I would imagine the damage is done, regardless of any
modification of the plan. Cypriots know that their savings are now on the
bargaining table. To be sure, there will be repeated reassurances that this is
a one-off event, but how trustworthy are such assurances? Indeed, if Greece is
any example, this will not be the last bailout, and thus plenty of time for the
European policymakers to insist on another bite at the apple. Perhaps if
authorities completely backtrack on the plan could they stave off a bank run,
but even on that I am not confident. Trust is easy to lose and hard to earn.

The bigger question is what does this mean for the European financial system
as a whole? Will depositors across the Eurozone view Cyprus as a unique
situation? Or will Greek citizens come to believe that the next tranche of
bailout funds might come with a new conditions to shore up government finances?
Will taxes on deposits be an element of any future bailouts? If so, Italian
and Spanish depositors might come to view their mattresses as safer than the
bank.

Perhaps expectations of a broader bank run are premature. Early
reports from Spain claim that no such run is in the making (of course, what
else would they say?). But I suspect this is still a game-changing event, sure
to make the financial system more unstable by aggravating the negative feedback
loop that surrounds financial crises. What else could be the case when you
remove a basic safeguard against panic in the banking system?

I can only sample the amazing amount of excellent commentary in response to
this new development. Frances Coppola,
in a must read piece, explains the economic consequences:

The effect of large and small depositors removing funds on that scale will be
a brutal
economic downturn as the money supply collapses. In particular, the dominant
financial sector will suffer a severe contraction, putting thousands of jobs at
risk and paralysing lending to Cypriot households and businesses. And that is IN
ADDITION to the estimated 4.5% economic contraction that is already happening
due to austerity measures imposed on Cyprus in 2012 to reduce its fiscal
deficit, and the further measures required in this bailout.

Yes, exactly how will this help Cyprus emerge from their recesssion? If you
guessed "it won't," you are correct. But expect European policymakerst to drone
on about how their plan will restore confidence in the economy of Cyprus.
Coppola also bemoans the culpability in the ECB:

The FT confirms the ECB's role in forcing through the deal. It says the ECB
threatened to stop providing liquidity to Laiki, Cyprus's second-biggest bank,
which would have caused an immediate disorderly collapse. I have written
previously about the ECB's disgraceful
behaviour. This is the worst example yet.

Like me, Karl
Whelan is challenged to see that this was a good choice:

Even if we get through the next week without panic, my gut feeling is that
this decision is a bad one and the Europeans should have chosen from the other
two options on the table. Over the longer-term, I doubt if financial
stability in the euro area (and the continued existence of the euro) is
compatible with a policy framework that doesn’t protect the savings of ordinary
depositors.

Nick
Rowe points out that savers in Cyprus are suffering
disproportionately because they lack the ability to print their own currency:

The difference is that inflation from printing too much money is a tax on
currency too. Cyprus cannot tax currency; it can only tax bank deposits.

Joseph Cotterill (another must read piece), identifies the reason to spread
the pain to small depositors:

The spin that this is about spanking money-launderers is rubbish. The 9.9 per
cent levy will be the cost of doing business for the average CIS corporate
shell, as Pawelmorski notes. More to the point, someone clearly balked at
increasing the rate above 10 per cent for big-ticket depositors — because why
else distribute pain to small holders to make up for it. Someone has an eye on
Cyprus somehow maintaining a future as an offshore banking centre.

Too big a hit to large depositors would end any hope that Cyprus could hold
onto its biggest industry. The anonymously penned
Some of it Was True blog wonders if there are any rules in European finance:

Probably of more lasting importance is the latest bout of rule-changing by
the authorities. Debt unwindings are generally well-defined in law. First
equity, then sub debt, then deposits and senior bonds together, and all treated
equally. Most of these principles have been tweaked over the last few years, but
the tweaks are getting steadily more aggressive. The ECB, holders of Athens-law
and foreign law Greek debt all got different treatment; the Dutch didn’t
restructure SNS Reeal paper, they confiscated it; the Irish banned lawsuits
against the ultimate wind-down of Anglo Irish. This is scratching the surface
compared with the rule-changes of the past but
it’s getting steadily more creative.The referee has gone from being
quasi-neutral arbiter, to pulling off his black shirt to reveal a Manchester
United one underneath and awarding himself a series of penalties. While there’s
clearly no point in market participants playing the shocked blushing virgin in
the face of a situation where the consequences of following the legally-logical
steps are socially unacceptable, the uncertainty generated creates costs too.

It was inevitable that we would be in crisis again. The austerity world view
of crisis resolution is completely at odds with the capacity of the euro zone’s
institutional architecture to handle a crisis. And so, we keep doubling down on
the same policy of austerity in exchange for reforms which has created the
downward spiral to begin with. I wish I could be optimistic here. But I think it
is going to get worse. I hope I’m wrong. And I certainly hope that periphery
depositors still have enough faith in the euro to ride this one out. If the
Cyprus panic metastasizes, it will get ugly.

Unbeknown to the Cypriot delegation members as they entered the hulking Justus
Lipsius summit building in Brussels on Friday night, their fate was already
sealed: their German counterparts wanted about €7bn for the estimated €17bn
bailout of their country to come from deposits
in the country’s banks.

“They were hand in hand with Finns, who were much more dogmatic,” said one
senior eurozone official involved in the 10-hour marathon talks that stretched
until 3am on Saturday morning. “Had that not happened, full bail-in,” the
official added, using the terminology for wiping out nearly all Cypriot bank
accounts.

Felix Salmon see the German influence as bad for Euope and Germany itself:

The Cypriot parliament is probably not going to revolt this weekend, but any
politician who votes for this bill is going to have a very, very hard time
getting re-elected. This decision is important not only because of the precedent
it sets with regard to bank depositors, but also because of the way in which it
points up just how powerless all the Mediterranean countries (plus Ireland) have
become. More than ever before, it’s Germany’s Europe. That’s bad for Cyprus —
and it’s not even particularly good for Germany.

"It was the position of the German government and the International Monetary
Fund that we must get a considerable part of the funds that are necessary for
restructuring the banks from the banks owners and creditors - that means the
investors," German Finance Minister Wolfgang Schaeuble told public broadcaster
ARD in an interview.

"But we would obviously have respected the deposit guarantee for accounts up
to 100,000," he said. "But those who did not want a bail-in were the Cypriot
government, also the European Commission and the ECB, they decided on this
solution and they now must explain this to the Cypriot people."

Bottom Line: In the short-run, the implications for the European periphery
might be limited. But, in the long-run, it is hard to see the assault on
Cypriot depositors as anything but a step backwards for financial stability in
Europe. This crisis remains far from over.